It has been nearly two years since the global sovereign debt crisis entered the mindshare of people worldwide in full force. The trigger for it was the revelation that Greece had falsified its budget figures and its deficit was nearly twice of what the previous Government had projected. Since then, reams of newsprint and millions of blogs, reports and articles have been dedicated to various aspects of the sovereign debt crisis.
The global monetary system has evolved over the past 40 years, since the time the US President Richard Nixon broke the US dollar from the Gold Standard (which had been established by the Bretton Woods agreement in 1944). Effectively, the value of the US dollar was backed only by the US Government.
Modern currency systems are what are called fiat systems; Each country adheres to a particular currency because the currency is declared to be the legal tender for that country by its government. So long as all the users (consumers) of money have faith in the government, they will continue to use the currency. Monetary standards stick so long as people believe in them. Consequently, the economic claims on all the resources of that country (whether held by domestic or international entities) are denominated in the currency of that country.
Money is a meta-asset; All other assets are denominated in it. It is a store of value. Additionally, it has its own supply and demand. In that sense, it is as much of a goods as any other. However, each currency is a monopoly of the government issuing it. This monopoly over the issuance of currency lowers the borrowing costs of the sovereign entity. All other credit curves and spreads get priced off the sovereign yield curve. Theoretically, the sovereign can avoid defaulting on its liabilities by issuing more currency (which will, no doubt, reduce the value of the currency issued by it)
Most of the major economies of the world have engaged at least in some form of monetary and fiscal profligacy. It is important to note that this is not a trend which developed post the Great Recession of 2008. Such profligacy had been in place even before 2008. No doubt, it exacerbated post the Crisis. The US, UK, China, India & some countries in Europe have all tested the bounds of fiscal and monetary expansion in one form or the other.
Because of this, firstly, the sovereign entities in most major countries no longer possess healthy balance sheets. They are running high debt/GDP ratios and fiscal deficits. The outlook for revenue growth correspondingly is weak. Secondly, in case of the countries with central banks which have engaged in monetary expansion (notably the US, UK & China), the credibility of the monopoly supplier of money has been lost. Hence, money declines in value.
In such a situation, the fiat money system at some point of time may get tested. Entities may start questioning as to why the sovereign should continue to retain a monopoly over the standard for valuing economic claims.
In this context, I came across an interesting paper titled the "Denationalisation of Money" by the Nobel Laureate, Professor Friedrich Von Hayek, first published by the Institute of Economic Affairs in 1976:
http://www.iea.org.uk/publications/research/denationalisation-of-money
While I haven't gone through the paper fully, I quote a couple of lines from the introduction which summarize the core idea:
"Professor Hayek is arguing that money is no different from other commodities & that it would be better supplied by competition between private issuers than by a monopoly of Government...Competitive currencies would remove the power of Government to inflate the money supply..."
Its a radical idea, no doubt. It strikes at the very roots of our economic system. One advantage of private money would be that sovereign risk would get priced appropriately. It would no longer by subsidized by the currency issuance monopoly enjoyed by sovereign entities.
Professor Hayek, however, may not have envisaged the massive expansion in the monetary and credit base that has taken place since 1971 (this is only my opinion; I have not read enough of his works to make that claim). Given the amount of financial assets outstanding in the world (going by McKinsey Global Institute estimates, it would be at least 4 times the world GDP, or at least 280 trillion dollars) I cannot conceive of a private entity which would have the balance sheet to meet the world's thirst for money. Therefore, even in the next 5 to 10 years, it is difficult to expect any sort of shift towards private money. If anything, post the Recession, the involvement of governments across economies has become even more pervasive than before.
However, if such a direct move towards private money is not possible, one should see entities with relatively strong credit fundamentals and real assets enjoying a premium for their financial assets. This has already been happening. Their financial assets will act as a proxy for any money which could be issued by them. Examples include the German government and certain US & Japanese corporations. Over a long period of time, the idea of private money may gain further acceptance.
What is more likely, however, in my opinion, is that healthy private entities may backstop government liabilities, either by force (PIMCO & Carmen Reinhart have elaborated at length on this topic, which they term financial repression: http://www.pimco.com/EN/Insights/Pages/A-New-Era-of-Global-Financial-Repression.aspx ) or willingly, in exchange for super-normal benefits
Till then, unfortunately, we are stuck with the dollars of the world!
The global monetary system has evolved over the past 40 years, since the time the US President Richard Nixon broke the US dollar from the Gold Standard (which had been established by the Bretton Woods agreement in 1944). Effectively, the value of the US dollar was backed only by the US Government.
Modern currency systems are what are called fiat systems; Each country adheres to a particular currency because the currency is declared to be the legal tender for that country by its government. So long as all the users (consumers) of money have faith in the government, they will continue to use the currency. Monetary standards stick so long as people believe in them. Consequently, the economic claims on all the resources of that country (whether held by domestic or international entities) are denominated in the currency of that country.
Money is a meta-asset; All other assets are denominated in it. It is a store of value. Additionally, it has its own supply and demand. In that sense, it is as much of a goods as any other. However, each currency is a monopoly of the government issuing it. This monopoly over the issuance of currency lowers the borrowing costs of the sovereign entity. All other credit curves and spreads get priced off the sovereign yield curve. Theoretically, the sovereign can avoid defaulting on its liabilities by issuing more currency (which will, no doubt, reduce the value of the currency issued by it)
Most of the major economies of the world have engaged at least in some form of monetary and fiscal profligacy. It is important to note that this is not a trend which developed post the Great Recession of 2008. Such profligacy had been in place even before 2008. No doubt, it exacerbated post the Crisis. The US, UK, China, India & some countries in Europe have all tested the bounds of fiscal and monetary expansion in one form or the other.
Because of this, firstly, the sovereign entities in most major countries no longer possess healthy balance sheets. They are running high debt/GDP ratios and fiscal deficits. The outlook for revenue growth correspondingly is weak. Secondly, in case of the countries with central banks which have engaged in monetary expansion (notably the US, UK & China), the credibility of the monopoly supplier of money has been lost. Hence, money declines in value.
In such a situation, the fiat money system at some point of time may get tested. Entities may start questioning as to why the sovereign should continue to retain a monopoly over the standard for valuing economic claims.
In this context, I came across an interesting paper titled the "Denationalisation of Money" by the Nobel Laureate, Professor Friedrich Von Hayek, first published by the Institute of Economic Affairs in 1976:
http://www.iea.org.uk/publications/research/denationalisation-of-money
While I haven't gone through the paper fully, I quote a couple of lines from the introduction which summarize the core idea:
"Professor Hayek is arguing that money is no different from other commodities & that it would be better supplied by competition between private issuers than by a monopoly of Government...Competitive currencies would remove the power of Government to inflate the money supply..."
Its a radical idea, no doubt. It strikes at the very roots of our economic system. One advantage of private money would be that sovereign risk would get priced appropriately. It would no longer by subsidized by the currency issuance monopoly enjoyed by sovereign entities.
Professor Hayek, however, may not have envisaged the massive expansion in the monetary and credit base that has taken place since 1971 (this is only my opinion; I have not read enough of his works to make that claim). Given the amount of financial assets outstanding in the world (going by McKinsey Global Institute estimates, it would be at least 4 times the world GDP, or at least 280 trillion dollars) I cannot conceive of a private entity which would have the balance sheet to meet the world's thirst for money. Therefore, even in the next 5 to 10 years, it is difficult to expect any sort of shift towards private money. If anything, post the Recession, the involvement of governments across economies has become even more pervasive than before.
However, if such a direct move towards private money is not possible, one should see entities with relatively strong credit fundamentals and real assets enjoying a premium for their financial assets. This has already been happening. Their financial assets will act as a proxy for any money which could be issued by them. Examples include the German government and certain US & Japanese corporations. Over a long period of time, the idea of private money may gain further acceptance.
What is more likely, however, in my opinion, is that healthy private entities may backstop government liabilities, either by force (PIMCO & Carmen Reinhart have elaborated at length on this topic, which they term financial repression: http://www.pimco.com/EN/Insights/Pages/A-New-Era-of-Global-Financial-Repression.aspx ) or willingly, in exchange for super-normal benefits
Till then, unfortunately, we are stuck with the dollars of the world!
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